Auditing and Ethics · Audit of Items of Financial Statements

Audit of Inventories for CA Intermediate

Updated 4 October 2026 · Fact-checked

Audit of inventories means gathering evidence that stock exists, is owned by the entity, is counted completely, is valued at the lower of cost and net realisable value, and is recorded in the correct period. Under SA 501 the auditor attends the physical count, tests count records, checks valuation and tests cut-off.

Understand Audit of Inventories

Inventory is often a large and risky balance. It is physically held, can be moved, can be damaged or become obsolete, and its value depends on judgement. So auditors treat it as an area needing direct evidence, not only books.

The audit asks five questions. Does the stock exist? Does the entity own it (or does it hold goods for others)? Is it complete, with nothing missed or double counted? Is it valued correctly? Is it recorded in the right period (cut-off)?

SA 501 says that when inventory is material, the auditor must obtain sufficient appropriate evidence about its existence and condition by attending the physical inventory count, unless it is impracticable. Management is responsible for the count and for its procedures. The auditor observes, inspects and test counts. The auditor does not take the count.

Valuation follows the applicable framework. Under AS 2, inventory is valued at the lower of cost and net realisable value. The auditor checks the cost method (FIFO or weighted average), the costs included, and whether slow-moving, damaged or obsolete items are written down.

If the count is on a date other than the balance sheet date, the auditor tests the movements between the two dates. If attendance is impracticable, the auditor performs alternative procedures. If sufficient evidence still cannot be obtained, the auditor modifies the opinion.

Key rules to remember

Valuation rule (AS 2): Inventory value = Lower of (Cost, Net Realisable Value); Apply item by item or to groups of similar items, not to the grand total of all stock.
Net realisable value: NRV = Estimated selling price − Estimated costs of completion − Estimated costs necessary to make the sale; Use selling price evidence close to the year end, including post year-end sales.
Roll-forward from count date: Book stock at year end = Stock counted on count date + Purchases (receipts) after count date − Issues / cost of goods sold after count date, at cost; Use when the count is before year end. For a manufacturer, include production movements: raw material receipts and issues to production, and finished goods transferred in from production and sold out. For a count after year end, the movements are reversed (roll-back): stock at year end = count stock − purchases (receipts) after year end + issues / cost of goods sold after year end.
SA 501 core requirement: Material inventory → attend physical count (unless impracticable) → else alternative procedures → else modify opinion; Attendance covers evaluating instructions, observing, inspecting and performing test counts.
Cut-off test: Last goods received and issued note before year end and first note after year end must match the period of the related purchase or sale entry; Check both inward and outward movements, plus goods in transit.

How to solve Audit of Inventories questions

Use this order for any inventory question, whether it asks for procedures, valuation or a scenario.

1Identify the assertion in the question: existence, completeness, rights and obligations, valuation or cut-off.
2State whether the inventory is material and what risks it carries, such as obsolescence, multiple locations or stock held by third parties.
3For existence, describe count attendance: review management's instructions, observe the count, inspect condition, do test counts both from the list to floor and floor to list.
4Add count controls to be noted: count sheets, tags, control of movements, separate marking of damaged or third-party goods.
5For valuation, check cost method, cost build-up, NRV and write-downs for slow-moving or obsolete items, and consistency with AS 2.
6For cut-off, record the last GRN and dispatch note numbers and trace them to the books, and review post year-end entries.
7If the count date differs or attendance is impracticable, give roll-forward or roll-back testing and alternative procedures.
8Conclude: sufficient evidence obtained, or modify the opinion if not.

Quickest way: E-C-V-C framework for inventory answers

When to use it: Use for MCQs and for the first 2 minutes of a written answer. It keeps you from missing a heading.

MCQs: if an option says the auditor should take the count, or that attendance is not needed, eliminate it. Management counts, the auditor observes and test counts.
MCQs: if the option says lower of cost and NRV, choose it over cost or selling price alone.
Written: write four headings, Existence, Completeness, Valuation and Cut-off, and put 2 to 3 points under each. Cover ownership in one line.
Written: give the SA reference (SA 501) once in the first line, then use plain action verbs like observe, inspect, test count, trace, agree.
Written: end with the consequence if evidence is lacking, which is a qualified opinion or disclaimer, depending on materiality and pervasiveness.

Common mistakes in Audit of Inventories

Writing that the auditor conducts the physical count.
Students mix up the auditor's role with management's role.
Fix: Write that management counts and the auditor attends, observes, inspects and performs test counts.
Doing test counts only from the stock list to the floor.
It feels like checking existence is enough.
Fix: Do both directions. List to floor tests existence. Floor to list tests completeness.
Valuing inventory at cost or at selling price.
Students forget the AS 2 rule.
Fix: Always say lower of cost and NRV, and check write-downs for damaged or obsolete stock.
Ignoring goods held for third parties or goods lying with others.
The focus stays on stock in the entity's own warehouse.
Fix: Mention ownership. Check segregation of third-party goods and obtain confirmations for stock held elsewhere.
Treating cut-off as only a year-end sales issue.
Students think only of revenue.
Fix: Test purchases, sales, goods in transit and returns. Compare the last GRN and dispatch note with the date of the entry.
Stopping at 'attendance was impracticable' with no further steps.
Students forget the alternative procedures requirement.
Fix: Say the auditor performs alternative procedures. If sufficient evidence is still not available, modify the opinion.

Worked examples

Example 1

A manufacturing company's stock is material. The count is on 28 March, but the year end is 31 March. State the auditor's procedures on existence and the year-end figure.

Show the solution

Attend the count on 28 March after reviewing management's count instructions.
Observe that count teams follow the instructions and that movements are controlled during the count.
Inspect the stock for condition and obsolescence, and perform test counts both list to floor and floor to list.
Record the last document numbers and obtain copies of count sheets for later tracing to the final stock records.
Test the movements between 28 March and 31 March: trace purchases and issues to GRNs, production records and dispatch notes.
Check the roll-forward: stock at 31 March = stock counted + receipts − issues after the count date, valued at cost. For a manufacturer, include production movements.
Review reconciling differences and ask management to explain them.

Answer: The auditor attends the count, observes, inspects and test counts, records cut-off and count sheet details, then tests the movements from 28 to 31 March to support the 31 March stock figure.

Example 2

At year end, the stock of item A is 500 units at cost ₹120 per unit. The expected selling price is ₹150 per unit, and selling costs are ₹40 per unit. No further costs of completion are needed. State the value at which the auditor should expect it to be carried.

Show the solution

Identify the rule: inventory is carried at the lower of cost and NRV.
Cost = 500 × ₹120 = ₹60,000.
NRV per unit = ₹150 − ₹40 = ₹110 (no costs of completion, so only selling costs are deducted).
NRV total = 500 × ₹110 = ₹55,000.
Compare: ₹55,000 is lower than ₹60,000.
Write-down needed = ₹60,000 − ₹55,000 = ₹5,000.

Answer: Item A should be carried at ₹55,000, so a write-down of ₹5,000 is needed. If the books show ₹60,000, the auditor communicates the misstatement to management and requests correction (SA 450). If it is not corrected, the auditor evaluates its effect on the audit opinion.

Exam tips

Quote SA 501 for attendance at the count and use the word 'impracticable' when explaining the alternative procedures.
For a scenario question, name the assertion being tested first, then give procedures. This gets step marks.
In valuation numbers, show cost, NRV and the lower figure in separate lines. Marks go to the working.
Remember that if the count is not attended and alternatives fail, the result is a modified opinion, not a mere note to management.
MCQs often hinge on one word: auditor 'observes' versus 'conducts', or 'lower of cost and NRV'. Read the options for that word.

Practice questions from Audit of Items of Financial Statements

Audit of Inventories in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Audit of Inventories: frequently asked questions

Is attendance at the physical stock count mandatory for the auditor?

If inventory is material, SA 501 requires the auditor to attend the count unless it is impracticable. If attendance is impracticable, the auditor performs alternative procedures. If these do not give sufficient evidence, the opinion is modified.

What is the difference between test counts from list to floor and floor to list?

List to floor selects items from the count records and finds them physically, which tests existence. Floor to list selects items on the floor and traces them to the records, which tests completeness.

How does the auditor test inventory cut-off?

The auditor notes the last goods received and dispatch documents before year end and traces them to the books. The auditor also checks entries just after year end to see that they belong to the next period.

What if the stock count is held at a date other than the balance sheet date?

The auditor still attends the count and then tests the movements between the count date and the year end. This supports that the year-end stock figure in the books is reliable.